CA Taxation & Compliance 2 — Questions and Answers
Question 1: A U.S. corporation has $500,000 of foreign-source income and pays $120,000 in foreign income taxes. If the U.S. tax on that income would be $150,000, what is the allowable foreign tax credit?
- $150,000
- $120,000 (Correct answer)
- $30,000
- $270,000
Correct answer: $120,000
The foreign tax credit is limited to the lesser of foreign taxes paid ($120,000) or the U.S. tax on foreign income ($150,000), so $120,000 is allowed.
Question 2: Under IRC Section 1031, which of the following exchanges qualifies for like-kind treatment?
- Rental apartment exchanged for a vacation home used personally 60 days/year
- Office building exchanged for farmland held for investment (Correct answer)
- Inventory exchanged for business equipment
- U.S. real property exchanged for foreign real property
Correct answer: Office building exchanged for farmland held for investment
Real property held for productive use or investment can be exchanged for any other qualifying real property, including farmland, under IRC §1031.
Question 3: Which penalty applies when a corporation fails to deposit employment taxes on time under the Trust Fund Recovery Penalty?
- 10% of underpayment plus interest
- 100% of the unpaid trust fund taxes assessed against responsible persons (Correct answer)
- 25% failure-to-pay penalty
- 5% per month up to 25% maximum
Correct answer: 100% of the unpaid trust fund taxes assessed against responsible persons
The Trust Fund Recovery Penalty equals 100% of unpaid trust fund taxes (withheld income and FICA) and is assessed personally against responsible persons.
Question 4: A self-employed individual with net self-employment income of $100,000 calculates the deductible portion of self-employment tax. What is that deduction?
- $7,065 (Correct answer)
- $14,130
- $7,065 × 0.9235 deduction
- $100,000 × 7.65%
Correct answer: $7,065
SE tax is 15.3% on 92.35% of net SE income; the deductible portion is one-half of SE tax, or approximately $7,065 on $100,000 net SE income.
Question 5: Under the U.S. transfer pricing rules of IRC §482, which method is generally preferred for tangible goods transactions?
- Profit Split Method
- Comparable Uncontrolled Price (CUP) Method (Correct answer)
- Transactional Net Margin Method
- Cost Plus Method
Correct answer: Comparable Uncontrolled Price (CUP) Method
The IRS's Best Method Rule favors the Comparable Uncontrolled Price method when reliable uncontrolled comparables exist, as it most directly measures arm's-length prices.
Question 6: Which of the following correctly describes the 'at-risk' rules under IRC §465?
- Losses are limited to the taxpayer's adjusted basis in the activity
- Losses are limited to amounts the taxpayer could actually lose economically, excluding nonrecourse debt in most cases (Correct answer)
- Losses are limited to passive income from other activities
- Losses are disallowed if the taxpayer materially participates in the activity
Correct answer: Losses are limited to amounts the taxpayer could actually lose economically, excluding nonrecourse debt in most cases
At-risk rules limit loss deductions to amounts actually at economic risk, which generally excludes nonrecourse financing except for qualified real property financing.
Question 7: A married couple filing jointly has $450,000 of AGI in 2024. Which surtax applies to their net investment income?
- No additional surtax applies at this income level
- 3.8% Net Investment Income Tax on the lesser of NII or AGI exceeding $250,000 MFJ threshold (Correct answer)
- 0.9% Additional Medicare Tax on wages only
- 2.1% Affordable Care Act surcharge
Correct answer: 3.8% Net Investment Income Tax on the lesser of NII or AGI exceeding $250,000 MFJ threshold
The 3.8% NIIT under IRC §1411 applies to the lesser of net investment income or the excess of MAGI over $250,000 for married filing jointly.
CA Taxation & Compliance 2
A U.S. corporation has $500,000 of foreign-source income and pays $120,000 in foreign income taxes.
If the U.S. tax on that income would be $150,000, what is the allowable foreign tax credit?